What are the avenues available to businesses with weak credit profiles or to
companies pursuing credit transactions that are perceived as too risky by credit
providers? Many companies apply for credit at banks, finance companies or
equipment leasing firms and are routinely rejected due to the high degree of
perceived credit risks. When approaching a credit provider, it is helpful to
understand what can be done to reduce the risk of a credit transaction in the
eyes of the provider. Never accept a credit rejection without considering credit
enhancements. Here are a few tips on credit enhancement to help guide you in
approaching the credit process:
1. Credit enhancements are modifications to credit transactions that improve
the risk-reward relationship for credit providers. Enhancements can be real or
merely perceived by the receiving party. Also, they can be tangible things like
real estate and equipment or they can be intangibles like future rights or
options.
2. Use credit enhancements to strengthen credit transactions and to improve
pricing or terms. They may be used to entice credit providers to approve credit
transactions that would otherwise be unacceptable because of the perceived
risks. They can also encourage credit providers to make transaction approvals
faster.
3. Credit enhancements usually fall within one of these general categories:
improvement in credit terms favoring the credit provider; additional collateral;
guarantees, insurance or third party assurances; increased pricing, compensation
or upside gain potential; or granting of specific rights or options.
4. Some specific enhancements include: granting a security interest in
additional equipment, real estate, inventory, accounts receivable, intellectual
property rights or other company assets; pledging cash; pledging securities;
third party guarantees; surety bonds; letters of credit; pledging cash value of
insurance; increase in transaction rate; additional fees or other transaction
compensation; shortening the term of certain transactions; granting first
refusal rights on future transactions; permitting call options; obtaining
re-marketing guarantees or agreements.
5. When considering using credit enhancements to improve your transactions,
use these guidelines: try to get a fair and objective assessment of your credit
profile and the inherent transaction risks from a knowledgeable credit person;
take inventory of the possible credit enhancements your firm can provide;
evaluate the cost of possible enhancements to decide whether using them will be
worthwhile; if there is time and opportunity for a second chance to present your
transaction to the credit provider, present it first without the credit
enhancement or with the minimum enhancement you think acceptable; of the credit
enhancements available to your firm, decide which ones will be effective and the
degree of enhancement necessary to achieve your objectives.
6. It helps to develop a credit enhancement strategy in the planning stage of
your transaction. Start by understanding the transaction?s credit strengths and
weaknesses. Decide which enhancements available to your firm will help
strengthen the risk profile of the transaction. Try to assess the credit
provider?s sensitivity to various types and degrees of credit enhancement.
Later, if the credit provider turns down your transaction or proposes
unacceptable terms, ask the provider to suggest enhancements that will make a
difference in the decision. You may be able to negotiate further, once you have
this information.
7. All credit enhancements have a cost. In many instances the cost is the
opportunity cost of not having the credit enhancement available for future use.
Before offering or providing a credit enhancement, do a thorough cost-benefit
analysis to make sure the potential benefit is worth the cost to your firm.
Though it is not always possible to enhance a credit to the satisfaction of
credit providers, you should understand the value of credit enhancements and
know when they may be useful. By carefully considering potential credit
enhancements, you can often improve the pricing and terms of your firm?s credit
transactions. If your firm has a weak credit profile, use of a credit
enhancement might make the difference between obtaining financing or being
rejected.
